Why Spain's Austerity Budget Is Doomed To Fail

A
demonstrator spraypaints the main door of the stock exchange
during a general strike in Barcelona, Thursday, March 29, 2012.
Spanish unions angry over economic reforms are waging a general
strike, challenging a conservative government not yet 100 days
old and joining other troubled European workers in venting their
frustration on the street.AP/Manu
Fernandez

Spain's blockbuster budget, announced yesterday, may look
disappointing at first sight. The only truly dramatic figure to
emerge was the total size of the adjustment: 27 billion. This,
said Cristobal Montoro, the budget minister, made it the most
austere budget Spain had faced since Franco's death in 1975.

By most measures it would indeed be a mighty adjustment. But much
of the figure was accounted for by income-tax rises and other
measures announced in a separate adjustment, worth 15 billion, in
December.

Moreover, yesterday's budget only covered Spain's central
government, not those troublesome regional governments and town
halls that have so many people worried. These have to make their
own adjustments, worth another 14 billion or so. Since regional
governments run health services and schools, they are faced with
the task of making cuts that many people will feel the most
acutely.

Mr Montoro, who was talking the day after a general strike saw
massive protests across Spain, was careful not to hit ordinary
Spaniards too hardor at least not directly. The cost of
electricity, gas and cigarettes will go up. But most of the rest
will come from corporate taxes, a fiscal amnesty, a civil-service
pay freeze and individual ministries (which must make cuts worth
an average 17%).

It will take a closer study to see whether all this delivers the
goods (a fuller explanation is due from the government next
Tuesday). But Mr Montoro is not the kind to fiddle the numbers.
And he can control the spending of ministries directly, which he
cannot do for the regional governments.

Assuming that accountants do not find ways to sidestep the new
rules, the government should be able to pull in the extra 5.3
billion or so it wants from tighter corporate taxes.

The amnesty is less of a sure thing. Mr Montoro is assuming that
25 billion or more will be dug out from under floorboards (if
that is where all those 500 notes hoarded during the building
boom went), or from offshore company accounts. People holding
such funds will pay taxes worth 8% or 10%, no questions asked.

The amnesty is supposed to produce 2.5 billion, a figure is based
on the experiences of countries like Italy. But who is to say
that Spaniards will respond the same way?

Mr Montoro stuck to his previous pledge not to hike sales tax,
which at 18% is low by European standards, saying he did not want
to hit consumers. Antonio Argandoa of the IESE business school in
Barcelona is among those who are surprised. "A 1% raise, for
example, would not have affected consumer spending," he says.

Sceptics see a sales-tax increase as inevitable if Mr Montoro is
to get last year's budget deficit of 8.5% of GDP down to 3% by
the end of next year, as the government has promised Spain's
European partners.

It has been a tough week for
Spain's ruling People's Party. The general strike came just four
days after the PP failed to win control of
Andalusia, Spain's largest state, in an election. Still, the
government's commitment to austerity seems undimmed. Ministers
insist they are fully aware that their credibility is at stake.

The real test will come later in the year, if Mr Montoro sees
that the measures he has introduced are insufficient to meet this
year's deficit target of 5.3%, or if the regions, despite central
government having new powers to fine them, fail to deliver on
their part of the bargain. The government may then feel obliged
to turn the screw tighter.